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I've heard many times that new investors should consider building a portfolio with low-cost index funds from Vanguard.
Here are a few reasons for the Vanguard index fund suggestion:
- mutual funds and ETFs can be purchased directly from Vanguard without paying a trading commission
- expenses associated with these funds are often very low
- index funds track market indexes, so performance generally tracks the market (that is, a portfolio of index funds typically won't beat the market but it should come close to matching market performance)
I've wondered how such a portfolio might be created. Here's what I've learned about possible steps:
Phase 1: Design the Portfolio
First, the model portfolio is designed in a conceptual phase. There are several ways to approach this task, including these:
- Consider using tools provided by Vanguard
Vanguard offers recommendations to its customers, either through the use of online tools or recommendations from one of its specialists.
Here are a couple of sample portfolios that I received:
ETF Portfolio (with expense ratios)
- Domestic Stock – 42% – Vanguard Total Stock Market ETF (VTI) – .05%
- International Stock – 28% – Vanguard Total International Stock ETF (VXUS) – .14%
- Bonds – 21% – Vanguard Total Bond Market ETF (BND) – .07%
- International Bonds – Vanguard Total International Bond ETF (BNDX) – .19%
Mutual Fund Portfolio (with expense ratio)
- Vanguard LifeStrategy Moderate Growth (VSGMX) (One-Fund Portfolio) – .16%
- Stock – 38%; International Stock – 22%; Bond – 29%; International Bond – 11%
- Consider The Coffeehouse Investor portfolio
The Coffeehouse Investor portfolio is one of the portfolios listed in MarketWatch as a “lazy portfolio.”
It's been developed by Bill Schultheis, author of the book The Coffeehouse Investor, who is prominent in Vanguard fund and “lazy portfolio” circles. The premise of the book and Bill's financial advisory and investing philosophy is that typical investors can't beat the market so they should consider putting money in low-cost market index funds and then directing excess energy toward career and personal interests.
As a result (hopefully), the investor's life can be rich by a) focusing on generating income at a regular job or business plus b) spending leisure time doing what is meaningful and enjoyable.
Note that I think investing is fun, not boring, so I haven't necessarily adopted this philosophy. Still, I thought it would make sense to peek at the investment portfolio on his website.
Here's the breakdown:
ETF and Mutual Fund Portfolio (with expense ratios)
- Fixed Income – 40% – Vanguard Total Bond Market Index Fund (VBMFX/BND) – .20%/.07%
- Large Cap Stocks – 10% – Vanguard 500 Index Fund (VFINX/VOO) – .17%/.05%
- Large Value Stocks – 10% – Vanguard Value Index Fund (VIVAX/VTV) – .23%/.09%
- Small Cap Stocks – 10% – Vanguard Small-Cap Index Fund (NAESX/VB) – .23%/.09%
- Small Value Stocks – 10% – Vanguard Small-Cap Value Index Fund (VISVX/VBR) – .23%/.09%
- International Stocks – 10% – Vanguard Total International Stock Index Fund (VGTSX/VSUX) – .22%/.14%
- Real Estate Investment Trusts – 10% – Vanguard REIT Index Fund (VGSIX/VNQ) – .26%/.12%
According to MarketWatch, this lazy portfolio has delivered annual returns of 5-6% over the last 10 years (depending on market fluctuations).
- Consider looking at portfolios from Mike Piper of the Oblivious Investor
Mike Piper, aka Oblivious Investor (one who doesn't pay much attention to the news headlines or do much stock analysis but invests steadily in index funds), is an index-fund portfolio champion and investor. Having read his ebook Social Security Made Simple, I have come to admire his work and positive efforts toward making complex subjects accessible to the average person (like me).
To achieve his goal of low-cost, simple investing, Mike uses Vanguard funds.To help readers start investing, he has designed eight sample portfolios that use one to eight Vanguard mutual funds or Vanguard ETFs. For example, here's his seven-fund portfolio:
ETF and Mutual Fund Portfolio
- Large Cap Stocks – 20% – Vanguard 500 Index Fund (VFINX/VOO) – .17%/.05%
- International Stocks – 20% – Vanguard Total International Stock Index fund (VGTSX/VXUS) – .22%/.14%
- Fixed Income – 15% – Vanguard Total Bond Market Index Fund (VBMFX/BND) – .20%/.07%
- Fixed Income – Inflation Protected – 15% – Vanguard Inflation-Protected Securities Fund (VIPSX/TIP from iShares, no Vanguard equivalent) .20%/.20%
- Small Cap Value – 10% – Vanguard Small-Cap Value Index (VISVX/VBR) – .23%/.09%
- Small Cap International – 10% – Vanguard FTSE All-World Ex-US Small-Cap Index (VFSVX/VSS) – .37%/.19%
- Real Estate Investment Trusts (REIT) – 10% – Vanguard REIT Index Fund (VGSIX/VNQ) – .26%/.12%
This portfolio is intriguing to me because of its inclusion of value stocks (large-cap value and small-cap value) and small-cap stocks (small cap and small-cap value), both of which have historically outperformed the general market. (Whether they will continue to outperform is unknowable). It also has real estate plus an inflation hedge via Treasury Inflation-Protected Securities (TIPs).
These are just examples to illustrate how others have designed a portfolio.
Phase 2: Build (Buy) the Portfolio
After selecting a design or making a model portfolio, the next phase is to consider buying shares of mutual funds or ETFs to build a portfolio based on the design. A portfolio could consist of both mutual funds and ETFs. But for simplicity's sake, I decided to look at creating a Vanguard mutual fund portfolio or a Vanguard ETF portfolio (but not mixing mutual funds and ETFs).
Note that Vanguard's set-up is slightly quirky compared to other brokerage firms. I can invest in its mutual funds without opening a brokerage account; however, if I open a brokerage account, I can buy either mutual funds or ETFs through the account. (For more on investing with Vanguard, see my review of this firm.)
Generally, the minimum is $3,000 to get started. A common minimum for an initial investment with a Vanguard mutual fund is $3,000; and the brokerage account minimum is $3,000.
There are two main ways of building a portfolio: 1) invest a lump sum amount or 2) invest a certain amount monthly. I'll illustrate both approaches.
Let's say I have $50,000 to invest. I could buy the Vanguard LifeStrategy Moderate Growth Fund (VSGMX), the one-fund portfolio and be done with this process. But if I wanted to build the seven-fund portfolio, then I could allocate my money like this:
- Vanguard 500 Index Fund (VFINX) – 20% – $10,000
- Vanguard Total International Stock Index Fund – 20% – $10,000
- Vanguard Total Bond Market Index Fund (VBMFX) – 15% – $7,500
- Vanguard Inflation-Protected Securities Fund (VIPSX) – 15% – $7,500
- Vanguard Small-Cap Value Index (VISVX) – 10% – $5,000
- Vanguard FTSE All-World Ex-US Small-Cap Index (VFSVX) – 10% – $5,000
- Vanguard REIT Index Fund (VGSIX) – 10% – $5,000
If I wanted to invest over time (or don't have $50,000 to invest right now), then I could start by making an initial investment and then adding to this total over time on a monthly basis:
- Vanguard 500 Index Fund (VFINX) – 20% – $3,000 – $7,000 – $291.67
- Vanguard Total International Stock Index Fund (VGTSX) – 20% – $3,000 – $7,000 – $291.67
- Vanguard Total Bond Market Index Fund (VBMFX) – 15% – $3,000 – $4,500 – $187.50
- Vanguard Inflation-Protected Securities Fund (VIPSX) – 15% – $3,000 – $4,500 – $187.50
- Vanguard Small-Cap Value Index (VISVX) – 10% – $3,000 – $2,000 – $83.33
- Vanguard FTSE All-World Ex-US Small-Cap Index (VFSVX) – 10% – $3,000 – $2,000 – $83.33
- Vanguard REIT Index Fund (VGSIX) – 10% – $3,000 – $2,000 – $83.33
- Total – 100% – $21,000 – $29,000 – $1,208.33
Let's continue to invest $50,000 but now with ETFs. Investing in ETFs is less expensive (initially) as I don't have to make a large initial investment: my minimum investment is simply the price of one share. However, I can't buy fractional shares through Vanguard so my purchase of the ETF portfolio suggested by Vanguard would look like this:
- Vanguard Total Stock Market ETF (VTI) – 42% – 211 Shares @ $99.54 – $21,002.94
- Vanguard Total International Stock ETF (VXUS) – 28% – 313 Shares @ $44.64 – $13,972.32
- Vanguard Total Bond Market ETF (BND) – 21% – 128 Shares @ $82.06 – $10,503.69
- Vanguard Total International Bond ETF (BNDX) – 9% – 85 Shares @ 52.96 – $4,501.06
- Total – $50,000 available – $49,980.54 invested
To spread my purchases over time, I might buy a few shares each month, investing about $1,000 monthly. My investing process might look like this:
- Vanguard Total Stock Market ETF (VTI) – 42% – 4 Shares @ $99.54 – $398.16
- Vanguard Total International Stock ETF (VXUS) – 28% – 6 Shares @ $44.64 – $267.84
- Vanguard Total Bond Market ETF (BND) – 21% – 3 Shares @ $82.06 – $246.18
- Vanguard Total International Bond ETF (BNDX) – 9% – 1 Share @ 52.96 – $52.96
- Total – $1,000 available – $965.14 invested
Notice that it's difficult to allocate my money precisely because I have to buy whole shares of ETFs and the prices are not whole dollars.
But these illustrations show how I might build a portfolio using a pre-established design. In addition, I'd monitor the balances and make adjustments by buying and selling shares to get the right allocation in sync with my model portfolio.
I've studied the investment returns of simple portfolios (such as The Coffeehouse Investor portfolio) and noticed that the growth is not very exciting. What I've learned is that such portfolios are not supposed to be exciting. They are created in the hopes of providing steady returns, not spectacular ones. They are built to offer a blueprint that is easy to maintain, one that can be followed in good times and bad times, one that allows me to ignore market fluctuations and just keep investing. They are for the lazy, oblivious, and steadfast investor.
Here are phases of my life when I might consider building and managing a simple portfolio:
- When I'm getting started and just need help doing something
- When I'm really busy and don't have time to build and manage a portfolio of individual stocks
- When I'm taking risks in my career but don't want to take excessive risks in my investing
- When I want to have a portion of my investments in a low-cost portfolio aligned with the market
Note that market index funds can be purchased from other providers besides Vanguard (such as Schwab and Fidelity). These are often available with low or no trading commissions and low expense ratios. But financial literature tends to promote Vanguard as its founder (John Bogle) spearheaded the index-fund movement.
Also, there are various ways of constructing a portfolio, including various allocations of stocks and bonds. In general, stocks are riskier and more volatile so as I move closer to financial goals (such as retirement), the more the model portfolios can be skewed toward bonds.
Finally, none of these portfolios are guaranteed to deliver a certain investment performance. None are made with my particular situation in mind. However, they may be useful in designing and building a low-cost portfolio, and controlling investment costs is an important aspect to accumulating wealth over time.